Question

Explain the following accounting policies

• Accounting conventions followed
• Valuation of fixed assets
• Depreciation and inventory policies
• Valuation of investments
• Translation of foreign currency items
• Costs incurred on research and development
• Historical or current cost accounting
• Treatment of leases
• Treatment of goodwill
• Recognition of profits on long-term contracts
• Treatment of contingent liabilities

Answer 1

Answer :

Accounting Conventions followed:

• Accounting conventions are guidelines used to help companies determine how to record business transactions not yet fully covered by accounting standards.
• They are generally accepted by accounting bodies but are not legally binding.
• If an oversight organization sets forth a guideline that addresses the same topic as the accounting convention, the accounting convention is no longer applicable.
• There are four widely recognized accounting conventions: conservatism, consistency, full disclosure, and materiality.

  There are four main accounting conventions designed to assist accountants:

• Conservatism: Playing it safe is both an accounting principle and convention. It tells accountants to err on the side of caution when providing estimates for assets and liabilities. That means that when two values of a transaction are available, the lower one should be favored. The general concept is to factor in the worst-case scenario of a firm’s financial future.
• Consistency: A company should apply the same accounting principles across different accounting cycles. Once it chooses a method it is urged to stick with it in the future, unless it has a good reason to do otherwise. Without this convention, investors' ability to compare and assess how the company performs from one period to the next is made much more challenging.
• Full disclosure: Information considered potentially important and relevant must be revealed, regardless of whether it is detrimental to the company.
• Materiality: Like full disclosure, this convention urges companies to lay all their cards on the table. If an item or event is material, in other words important, it should be disclosed. The idea here is that any information that could influence the decision of a person looking at the financial statement must be included.

Valuation of Fixed assets :

Method 1 - Capitalise assets

• Fixed assets are shown on the balance sheet at historical cost less depreciation. Depreciation is calculated to write off the cost less residual value of each asset over its expected useful life.

  This method is required by International Financial Reporting Standards (IFRS).

  Method 2 - Expense assets

• Fixed assets acquired during the year are shown on the Income and Expenditure Statement as capital expenditure.

  This method is often required by donors.

  Method 3a - Capital grants fund (Both 1 and 2)

• Fixed assets funded by grants are expensed from restricted grant funds in the year of purchase and transferred to the capital grants fund. Fixed assets are shown on the balance sheet and depreciated through the capital grants fund at rates calculated to write off the cost less residual value of each asset over its expected useful life.

  Method 3b - Capital fund (Both 1 and 2)

• All fixed assets are expensed from revenue funds in the year of purchase and transferred to the capital fund. Fixed assets are shown on the balance sheet and depreciated through the capital grants fund at rates calculated to write off the cost less residual value of each asset over its expected useful life.

Depreciation :

The calculation and reporting of depreciation is based upon two accounting principles:

• Cost principle. This principle requires that the Depreciation Expense reported on the income statement, and the asset amount that is reported on the balance sheet, should be based on the historical (original) cost of the asset. (The amounts should not be based on the cost to replace the asset, or on the current market value of the asset, etc.)

• Matching principle. This principle requires that the asset's cost be allocated to Depreciation Expense over the life of the asset. In effect the cost of the asset is divided up with some of the cost being reported on each of the income statements issued during the life of the asset. By assigning a portion of the asset's cost to various income statements, the accountant is matching a portion of the asset's cost with each period in which the asset is used. Hopefully this also means that the asset's cost is being matched with the revenues earned by using the asset.

There are several depreciation methods allowed for achieving the matching principle. The depreciation methods can be grouped into two categories: straight-line depreciation and accelerated depreciation.

The assets mentioned above are often referred to as fixed assets, plant assets, depreciable assets, constructed assets, and property, plant and equipment. It is important to note that the asset land is not depreciated, because land is assumed to last indefinitely.

Inventory :

companies are allowed to value inventory using the average cost, first in first out (FIFO), or last in first out (LIFO) methods of accounting. Under the average cost method, when a company sells a product, the weighted average cost of all inventory produced or acquired in the accounting period is used to determine the cost of goods sold (COGS).

Under the FIFO inventory cost method, when a company sells a product, the cost of the inventory produced or acquired first is considered to be sold. Under the LIFO method, when a product is sold, the cost of the inventory produced last is considered to be sold. In periods of rising inventory prices, a company can use these accounting policies to increase or decrease its earnings.

For example, a company in the manufacturing industry buys inventory at $10 per unit for the first half of the month and $12 per unit for the second half of the month. The company ends up purchasing a total of 10 units at $10 and 10 units at $12 and sells a total of 15 units for the entire month.

If the company uses FIFO, its cost of goods sold is: (10 x $10) + (5 x $12) = $160. If it uses average cost, its cost of goods sold is: (15 x $11) = $165. If it uses LIFO, its cost of goods sold is: (10 x $12) + (5 x $10) = $170. It is therefore advantageous to use the FIFO method in periods of rising prices in order to minimize the cost of goods sold and increase earnings.

Valuation of Investments:

• Investment value and fair market value are two terms that can be used when evaluating the value of an asset or entity.
• Investment value usually refers to a broader range of values resulting from a variety of different valuation methodologies.
• Fair market value is based on the market value of an asset or entity with latitude for adjustments depending on the analysis of market transaction circumstances.
• Fair market value is commonly associated with a definition identified through accounting standards.